The Coronavirus has grabbed the world’s attention in a major way. The outbreak in China hit a new plateau on Tuesday with the number of confirmed cases exceeding 20,000 with more than 420 deaths. For the time being the market impact has been controlled, in part, by massive capital infusions from the Central Bank of more than 240 billion over the last several days.
Global commerce is certainly slowing with entire Chinese cities being quarantined, airlines suspending service and many global companies suspending operations due to the illness, leading to supply chain disruptions. Regardless of how one feels about the medical aspects of the Coronavirus, paying attention to the financial consequences of this event is a lesson in prudent risk management. While the market impact could be just a small speed bump in a roaring bull market, a continuing escalation of the situation could bring on a correction in an overvalued market that is looking for an excuse to take a breath.
The chart above shows the price of the S&P 500 ETF(SPY) in the top window with the corresponding weekly Relative Strength Index (RSI) reading on the bottom. RSI measures how much momentum a certain market or stock has. Most of the time, the RSI muddles between a reading of 30 and 70 and doesn’t provide much useful information. But sometimes the reading becomes stretched, as denoted by the yellow circles above. Stretched readings indicate the current price movement is reaching an unsustainable trajectory. Think of a car that is overheating and needs some time to cool down before it boils over.
Why Do We Care?
What does RSI have to do with the Coronavirus? The increased volatility we have seen over the last two weeks results from a combination of an overheated/overvalued market (the second yellow circle above), and the acceleration of both the number of confirmed cases and precautions being taken to slow the spread of the virus. The good news is that even after the overheated RSI reading collided with the “worry” phase of the Coronavirus, the market only declined a bit more than 2% from its all-time highs before going back into rally mode as I write this. So, what do we do now?
Make no mistake, you don’t quarantine 46 million people for the “flu”, which is exactly what China has done to slow the spread of the virus. In addition, it is being widely reported that life in quarantined cities has essentially stopped: no school, no work and no travel. China remains the largest component of the emerging market universe and an important link in the global supply chain. Taking all that production offline for the foreseeable future is going to have a measurable impact, the extent of which is currently unknowable.
In addition, we are already seeing other parts of the global economy beginning to suffer. Oil has now entered a bear market as Chinese demand forecasts have been lowered. Airlines are pulling routes to and from China. Food and Beverage companies with operations in China have seen a dramatic drop in traffic. It all starts adding up. Unfortunately, the spread of the virus doesn’t seem to have slowed at all, yet.
China’s Central Bank is wasting no time combating the drop in demand, having injected large sums of capital into their markets as they re-opened after the New Year’s break. They also banned short-selling and requested that insiders with large positions pledge to hold their assets for at least the next 6 months. This is a global situation that continues to evolve.
Is it time to panic? No. Is it time to be concerned? Yes. Is it time to plan? Absolutely. While most of the Coronavirus cases have been confined to China, we are seeing new confirmations almost daily in other parts of the world, including the United States. If this trend continues or accelerates, we expect market volatility to increase along with it. In that scenario, we would execute our established risk management procedures and reduce portfolio risk accordingly. But what if this turns out to be just another flu? In that scenario, HCM feels it would create an opportunity to buy asset classes that have suffered during this outbreak. Emerging Markets are one area that has been hit especially hard over the past few weeks and could offer very compelling valuations.
Weekly Focus – Think About It
“A goal is a dream with a deadline.”
Performance last week for the four major asset classes were:
- U.S. Stocks – Russell 3000 (IWV) – Loss of -2.09%
- Developed Foreign Markets (EFA) – Loss of -2.89%
- Emerging Markets (EEM) – Loss of -5.58%
- Fixed Income (AGG) – Gain of 0.76%
(Note: performance is based on the change in price plus dividends)
Last Week’s Headlines
- On the economic front, the fourth-quarter GDP showed that the US economy grew at a 2.1% annual rate, which was in line with consensus forecasts
- Markets sold off on concerns about the spread of the coronavirus that originated in China and the effect it will have on global growth
Eye on the Week Ahead
- Nonfarm Payrolls will be released at the end of the week and provide an update on the health of the labor force
If you have questions about the recent market conditions, please contact a member of HCM’s Wealth Advisory Team:
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